The previous chapter listed financial literacy as a core competency requirement within the SANDF. However, no reasons were given as to why it is important as a personal mastery skill. Therefore, this section will aim to establish the importance of financial literacy by making a case on the global, national, and organisational level as to why it is so important. The case for financial literacy is bigger than just being a skill requirement set for young officers within the SANDF. Globally, nationally and at organisational level there is a need for individuals to improve their financial knowledge and financial behaviour. Changing markets and technology, changing support structures and personal changes necessitate an improvement in financial knowledge and behaviour. The result of financial literacy is individuals that are better informed, markets that will function more effectively, and social cohesion and personal wealth that will improve. Wealth improvement, however, is not only the result of increased knowledge, but also of behaviour such as increased saving, better management of debt, retirement provision, and can result in less financial stress and increased effectiveness.
Conversely, if financial knowledge and behaviour does not improve, stakeholders remain confronted by a situation of low savings, high debt, little provision for retirement and ultimately high financial stress levels and ineffectiveness in the work environment. There are many more consequences of financial illiteracy that can be listed at a global, national, and organisational level, and most of them involve the individual and are not restricted to any level.
It would be prudent to begin at the highest level of concern, and that is the global level. According to the Oxford English Dictionary (1989), global as a concept has replaced international, “… is a synonym of worldwide, and means of, or relating to, or involving, the entire world in the general sense or as the planet Earth”. It is “… a way of referring to issues, processes and structures that affect human beings collectively”,
and the primary issues of concern are the use of scarce resources and the attainment of social cohesion.
Any financial decision made by the individual is a claim against global resources.
Even when an individual refrains from acting, it is a financial decision with consequences for society. Global organisations are therefore concerned with the financially-related decisions made by individuals and the quality of those decisions, because they affect the world economy by affecting social cohesion and financial markets.
Social cohesion according to Johnston (2005: 1), Secretary General of the Organisation for Economic Co-operation and Development (OECD), is what enlightened societies strive to ensure, and depends primarily on savings and the building of capital. He pronounced that imbalances of wealth will undermine this cohesion and therefore countries should address the creation and distribution of wealth through financial education. Social cohesion, from an American perspective at a more fundamental level, is the social fabric and national image, and are intimately connected to material aspirations and having the tools and ability to improve lives and livelihoods (NCEE, 2002: 4). Therefore, people should be financially literate to apply their tools and abilities effectively within financial markets, and as a result, financial markets will distribute limited resources more effectively (Clementi, 2004: 1).
Krueger (2002: 19-20), Deputy Managing Director of the International Monetary Fund, at the Financial Literacy International Conference in 2006, questioned the effective application by individuals of financial abilities. She referred to the demonstrations against globalization and expressed her concern that demonstrators advocate the opposite of what they actually covet, based on a lack of financial knowledge. Examples of these expressions are the fear that globalization will lead to lower labour and environmental standards, and that the relationship between debtor nations and creditors is exploitive in nature (NCEE, 2002: 3). She concludes her argument by stating that the more economically literate people are, the more productive debates would be on global issues, and this would result in a more productive and economically viable society. In the same vein, Braunstein and Welch (2002: 445) contend that the poor financial literacy illustrated by consumers compromises market operation and competitive forces.
The effective functioning of markets, and therefore financial literacy, is even more important at the national level where governments intervene by means of regulation.
Financial markets are the result of the financial activities of individuals and organisations, but also influence the activities of those role players. For markets to operate efficiently, consumers should be knowledgeable and illustrate the relevant behaviour and skills (Anon, 2006: 1). As stated by Hilgert and Hogarth (2003: 309), in classical economies the informed consumers act as the checks and balances that keep unscrupulous sellers out of the market, and are less likely to react prematurely or overreact, which will allow governments to limit the regulation of financial markets.
Feslier and Crossan (2006: 7-9) elaborates on the relationship that exists between financially literate consumers and regulation. Firstly, if regulation were complex consumers would need more knowledge. The complexity of disclosures, because of regulation, with regard to products, services, fees, risks and returns requires advanced financial understanding. Secondly, if regulation is light handed consumers need to be more alert and understand products and financial principles even better to be safe. Either way the consumer needs to be financially literate, but as indicated by Feslier and Crossan (2006: 7-9), and the OECD (2005c: 4), financial training and education should complement regulation rather than replace it.
Limiting regulation in practice is not as easy as just excluding it. Although governments are trying to limit regulation and their involvement in the market, changing demography, amongst other things, is posing challenges to them. Firstly, there is a growing trend globally for governments to limit their involvement in the market by reducing their responsibilities as income, pension, and tuition fee providers. This will mean that individuals have to provide for themselves and need to be educated to do so. Secondly, because of changing demographies, countries are becoming more diverse and need to integrate foreign-born households and minorities within existing financial systems (Anon, 2006: 1).
The integration of minorities, however, is not always effective and should be complemented by financial education. A case in point is the USA where foreign-born households, such as Hispanics and African-Americans’, net worth is far less than that of white Americans (NCEE, 2002: 2). The integration of minority students, according to Muir (2005: 38), is also not effective. Minority students in the USA are financially less literate than their counterparts, they are more likely to drop out of university due to financial problems, and they are not able to depend on their parents for financial
help. These groups encounter language, educational and cultural barriers that discourage a banking relationship with financial institutions. Not only does the banking relationship educate financially, it also encourages saving and acts as a vehicle for government intervention. International research suggests that 51% of households that have a banking relationship save regularly, compared to the 14%
that do not (Braunstein & Welch, 2002: 448), and there is a move at government level, especially in the USA and UK, to make electronic payments of income and benefits into a bank account compulsory (OECD, 2005a: 78).
As stated earlier, markets are the result of the financial activities of individuals and organisations, and because of the needs of individuals and organisations, markets have to incorporate changing technology and be creative in developing new products and services. The needs of individuals and organisations disturb the equilibrium of markets and as a result technology changes and market innovation is applied by suppliers as is noted by Braunstein and Welch (2002: 445-448). This improved technology and innovation leads to the transformation of the marketing, delivery and processing of financial products and services, and products such as Internet banking, cell phone transactions, and auto bank transactions, which complement over-the-counter transactions, become available. As a result, knowledge imbalances occur between suppliers and consumers, and there is a decrease in the banking relationship that can and should be corrected through financial education (Todd, 2002: 6) (Hodge, 2006: 25).
Knowledge imbalances are also the result of the increased availability of consumer information databases, and can lead to the development of exact fitting products and services that can, unfortunately, lead to fraudulent exploits. The more accurate credit assessments lead to an increase in loans extended. Although loans become more attractive and flexible, consumers may end up with more expensive accounts, increased monthly fees, overdrafts, or excessive transactions if they are not careful.
Two types of loan transaction that require consumers that are knowledgeable warrant mentioning. The first is questionable mortgage lending and the second is payday lending.
Questionable mortgage lending is a loan with small premiums but large balloon payments at the term of maturity and although in most cases are not technically illegal, they are inappropriate and detrimental to most consumers. However, to regulate this practice would restrict needed access to credit, and therefore,
consumers should rather have more knowledge. The second loan transaction is payday lending or predatory lending, where money is borrowed on a future pay cheque. Payday lending is a huge industry in the USA, according to the Center for Responsible Lending, as quoted by Gross (2004: 4). They estimate that predatory lending strips $16 billion in wealth from American consumers annually, and that this industry grew almost 1 000% in the 1990s. In 2003 payday lenders charged $4.3 billion to lend $25 billion (Gross, 2004: 4), an annualized average cost of 300%
(NCEE, 2002: 2). Therefore, changes in technology and market innovation can be beneficial to financial institutions at the cost of unknowledgeable consumers.
From a national perspective, the changes in technology and market innovation also force individuals to react. Their needs and responsibilities change with the market changes, and they have to make knowledgeable decisions and then implement these decisions. The main questions that individuals face in order to meet their needs and responsibilities are asset accumulation, debt management, and retirement provision.
According to statistics and research that will now be quoted, individuals are not coping with these questions. Results of various studies indicate a decrease in asset accumulation such as savings, an increase in debt and default on debt, insufficient retirement provision, low financial literacy scores, high financial stress levels and as a result ineffectiveness in the work environment. These are all the result of people not having the necessary financial knowledge and demonstrating incorrect financial behaviour which is of concern globally, nationally and at organisational level.
The first activity of concern is asset accumulation activities, such as saving and having your own business. These are important to both society and the individual.
For society and government, an increase in saving, ceteris paribus, leads to an increase in money supply, a decrease in interest rates, and an increase in investment and therefore economic growth. For the individual in the short term, savings act as a cushion against misfortune and in the long term they make provision for retirement and home ownership (OECD, 2005a: 78).
Savings, according to various surveys are not enough and start too late. In the USA the savings to disposable income (DI) ratio decreased from 8.7% in 1992 to 0% in 2000 (Greenspan, 2002: 41). According to the Wealth Span Model that compared the life-long savings and spending patterns of Americans in 1930 with the patterns of 2000, saving also starts too late. Asset accumulation in the 1930s started at 20 years and continued to 60 years compared to 25 to 65 in the year 2000. Another
saving-for-retirement concern is longevity. In the 1930s a maximum of 20 years were spent in retirement compared to the expected average of 35 years in 2000. The result is that there is a 44% chance that a 60-year-old child will have one parent alive and in need of care compared to 7% in 1900 (Cutler, 1997: 39).
Managing a small business also contributes to asset accumulation. Small businesses generate almost 50% of the private gross domestic product in the USA, are a vehicle for minorities to gain access to finances, and could be an effective allocator of capital. That is, if managers manage effectively. A survey done by Brown, Saunders and Beresford (2006: 183-191), on small businesses in the UK concludes that of a list of 17 issues queried by 95 owner-managers within the previous six months of business, financial issues such as funding, finance and accounts proved to be at the top. Although these issues are at the top, only 11% of the owner-managers participated in finance/account training, even though 95% indicated themselves to be less than “very confident” on their finance and accounts personal skills. This contradiction is supported in rating the perceived importance of financial awareness, skills and literacy. Of the seven important business knowledge areas, finance/accounts rates in the bottom three, behind marketing/selling, technical skills, interpersonal skills, and business planning. In summary finance/accounts is the most consulted area, least educated/trained for, and perceived to be of the least importance. The irony is that this sample still had an 86% survival rate over their debt.
To many consumers debt is the answer to insufficient savings, although it is intended to be a vehicle for short-term liquidity problems. In other words, to purchase or pay for something that you will have the money for at some later stage. However, with the increase experienced in economic growth and per capita income, and a decline in interest rates, credit has become more accessible (OECD, 2005a: 33). Inversely, savings drop with the increase in debt and this ultimately results in bankruptcy. A case in point is the 1.4 million Americans who filed for personal bankruptcy in 1998.
Although household debt consists of either consumer credit or mortgage credit, and indebtedness is mainly due to home mortgages, the misuse of credit remains the primary cause of bankruptcy. At the State of Financial Literacy in America conference, some of the following credit statistics were presented:
• Sixty percent of American households carry over some portion of their credit card debt every month. The average balance is more than $4 000.
• Twenty percent of families with an annual income of below $50 000 spend close to half of their net income on debt payments.
• More than 2.5 million families and individuals are estimated to seek professional help by means of credit counselling each year (OECD, 2005a: 63).
• In 1999-2000, 1.27 million American households declared bankruptcy.
• Between 1990 and 1999, there was a 51% increase in annual bankruptcy filings among adults of 25 years of age and younger. These increases also manifest in the UK, Korea, and Austria.
Students, the subject of this research, are not doing any better than the average American in managing their debt. More than 33% of American students have a credit card even before they start their studies, and 44% acquire one in their first year (Braunstein & Welch, 2002:448). Of all American college students, 20% had four or more credit cards in 1998 (Warwick & Mansfield, 2000: 618), and according to Boss (2002:13), 10% of American college students owed more than $7 000 on their credit cards before graduation. The median debt per student in 2001 was $1770, an increase of more than $500 from the previous year (Beverly & Burkhalter, 2001:122).
Due to the debt banks suffered $3.8 billion in losses on credit cards and consumer loans in 1996 (Warwick & Mansfield, 2000: 617), and as a result the fastest-growing group declaring bankruptcy is young adults, aged 20-24 (Greenspan, 2002: 41). This situation is of major concern, because according to Simpson (Warwick & Mansfield, 2000: 619) Indiana University claimed that they lost more students to credit card debt than academic failure.
Although the misuse of credit is the primary cause of bankruptcy, a lack of knowledge and ineffective financial behaviour is also to blame. Mavrinac and Ping (2004), as quoted by the OECD (2005a: 65), support this statement by suggesting that for the majority, debt is due to financial illiteracy rather than a lack of income. The findings of the Commonwealth Bank of Australia also indicate a significant relationship between defaulting on mobile phone, credit card and utility bills payments and low financial literacy (Anon, 2005: 9). If these statements are correct, there is major reason for concern, because financial literacy scores are low throughout the world. Table 3.1 indicates the scores achieved internationally by individuals on various financial issues.
Table 3.1: International Financial Literacy Survey Results
• New Zealand: 54% of respondents believed that fixed income investments provide higher return than stocks over an 18-year period.
• German survey by Commerzbank AG in 2003: Although 80% were confident on their understanding of financial issues, only 42% could answer half of the questions correctly.
• A survey in Japan found that 71% of respondents had no knowledge about equities and bonds; 57% had no knowledge about financial products in general; and 29%
had no insurance or pension knowledge.
• Korean students answered less than 60% of questions to a financial literacy test correctly in 2003
• An Australian survey found that 37% of investors were not aware of the possible fluctuation in investment value, and of the 67% that understood compound interest, only 28% could actually apply it.
• An adult survey indicated that 21% of those who received and read superannuation statements did not understand them.
• When asked four questions on a bank statement, only 49% answered all questions correctly.
• The USA National Council on Economic Education survey: Adults scored average C;
School population scored F (ave = 53%)
• University of Michigan’s 2001 Survey of Consumers tested 1000 respondents: Only 56% knew that shares have the highest return of all long-term investments. Of the 28 questions in the quiz, Americans could only answer two-thirds correctly.
• 2004 Health and Retirement Study: Only 18% could compute a compound interest calculation correctly.
• Grade 12s scored an average of 52.3% in the 2004 personal finance survey.
• Students taking personal finance or economics performed worse than average during 2000 and 2002 surveys. This position improved in 2004.
Sources: Lusardi and Mitchell (2007:36-39), Swart (2005:49), Johnston (2005: 2), Moorer (2001: 18), OECD (2005a: 42-44).
The misuse of debt, however, is not only due to a lack of knowledge but also due to poor financial behaviour. In other words, it is caused by ineffective financial behaviour by consumers and students alike. Research by the University of Michigan illustrates a financial practices index that reflects the frequency of financial management activities of consumers tested (Hilgert & Hogarth, 2003: 311). The results indicated that only 66% of respondents take part in cash-flow management
activities; 45% in credit management; 33% in savings management; and 19% in investment management.
Earlier, in 1999, the Americans for Consumer Education and Competition’s (ACEC) research on student financial behaviour found that only 23% of the respondents created and followed a budget (Beverly & Burkhalter, 2001:121). Fifty-four percent of these students compared prices often, and 23% often tracked expenditures. Another survey of more than 1 000 students at 27 colleges and universities and 19 states by Students in Free Enterprise (Anon, 2002: 10) found that:
• Although 92% know how to balance a cheque book, only 62% actually do it;
• 38% prepare a monthly budget, but 28% do not stick to it;
• 74% of men stick to a budget compared to 69% of women;
• 39% of men have investments compared to 31% of women;
• 66% of women balance their chequebooks compared to 56% of men.
Therefore, people are not saving, and they are in debt because of unknowledgeable and ineffective financial behaviour. What does this mean for retirement? One would expect retirement provision to be poor given the low savings rate. Added to the low savings rate are the additional global issues of decreased government support, and the challenge posed by the baby boomers of WW II (OECD, 2004: 223; OECD, 2005a: 29). The baby boomers are a generation that delayed childbearing or had
Therefore, people are not saving, and they are in debt because of unknowledgeable and ineffective financial behaviour. What does this mean for retirement? One would expect retirement provision to be poor given the low savings rate. Added to the low savings rate are the additional global issues of decreased government support, and the challenge posed by the baby boomers of WW II (OECD, 2004: 223; OECD, 2005a: 29). The baby boomers are a generation that delayed childbearing or had